Gary Wright

Gary Wright - BISS Research

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HFT a force for good or evil

29 October 2012 | 3856 views | 3

It seems to me that the Industry is split between the benefits or not, of high frequency trading (HFT) and it’s a polarisation which is so concerning that Sir John Beddington, UK Government Chief Scientific Adviser, has launched his report on the Future
of Computer Trading in Financial Markets.

Everyone appears to have an opinion, but very few of these are based on a sound understanding of trading – at a speed of which most average people have trouble grasping. Politicians and the man in the street treat HFT as the perfect target for the problems
in the market. This view is very much based on rhetoric and envy of the huge profits that financial institutions are reported to have made and the salaries reported to be paid to traders. This negative opinion of HFT has now passed into folk law where this
type of trading is referred to as ‘the Casino’.

This view is not correct and misses the benefits that HFT brings. To decide if HFT is good or bad both sides of the argument must be understood.

Whilst the supporters of HFT will normally point out the increased liquidity that algorithmic trading brings and the reduction in spreads that can be enjoyed by investors.

In reality I don’t believe that both arguments hold much water. The fact is that technology allows HFT and the structure of the markets opens the doors for this type of trading, but the investing community cannot see any evidence of tangible benefit.

We have in today’s market a two speed structure that hardly relates to each other. The vast majority of transactions traded each day are between Banks utilising HFT, to take advantage of a buying or selling opportunity in milliseconds. This activity has
nothing to do with human decision making other than the flip of a switch. The algorithms that instigate HFT have no strategy and do not take into account company performance, historical analysis of share prices or any market condition other than the rise or
fall in share prices. It is in fact a dichotomy as HFT activity accelerates and increases the volatility of share prices. It is therefore a self-fulfilling prophecy leaving investors at the whim of a mathematical equation. The rise and fall of share prices
and market performance is therefore irrelevant. This is exactly the opposite of investing. It is pure and simple trading.

Consequently, Investment firms have been moving on mass to long term strategies, based on traditional analysis and the decision to buy or sell. The vagaries in today’s market are pretty meaningless in the long term.

The volatility in markets has rarely got much to do with economic outlook, unless it triggers a genuine sale order by long-term, large investors. Over a week the markets can swing madly up and down and end up just about where it started - hardly an attractive
proposition to encourage investors, but perfect for day traders and HFT.

Society has to decide what sort of financial market it wants. There is nothing wrong with HFT, but it’s not really helpful for the increase in real investments or for new companies to list. Who wants to bring a company to market when its share price is at
the beck and call of machines?

Do we want a Stock Market that attracts investors and companies to list and find capital to build new factories or develop new products? Do we want a Stock Market that contributes to economic growth but possibly is a tad more expensive?

HFT is here and it’s a successful business generating vast profits for those that can play. However, it is ‘the Casino’ and does not provide much benefit for long or shorter term investors.

As in all things in life, we need balance. With my Market Making background I have an affinity to trading, however, with technology and HFT we have a created a business that has unbalanced Stock Markets and is preventing them from fulfilling the basic investment
and growth functions for which they were created.

We cannot have it both ways! HFT is either made illegal or at least artificially slowed down. Maybe a transaction tax on HFT trades would bring some consideration in to the creation of the algorithm and slow it down. Or maybe we need a new Stock Market where
HFT does not form part of the market making services and where investors and SMEs are attracted to list.

Comments: (4)

HFT has been "used " by our exchanges to increase their profits and been tarred with the bad brush .

We can accomodate HFT but not on a 70% share as clearly that blend does not suit our markets and therefore we need our exchanges to change their governance and become independently regulated and provide

honest markets for ALL their clients . The exchanges created HFT and have to share its faults and blame . Finally we can say that they have not created the liquidity and volume they promised and therefore have dented the markets confidence and May 6th 2010
can never happen again !

I would daresay that this dual structure that you are mentioning currently exists. There is the lit world of exchange trading, which is pretty much dominated by HF and Algo trading to the detriment of small and medium-sized investors.

On the other hand there is the world of "dark pools" where large-scale transactions are being brokered away from the lit markets to ensure that asset managers, hedge funds and large broker-dealers can move significant amounts of e.g. shares without (a) disrupting
the market by initiating larger price moves and (b) be disrupted by the ever-vigilant algorithms.

That, though, seems to be lost to rule-makers who want to drag dark pools into the light again and thus make these large-scale transactions probably more costly and less efficient as today.

This, by no means, is a call to keep shadow banking alive. But as with the discussion around HFT there are "good" dark/grey areas of the financial market and those which are only looking to exploit to the detriment of small and medium-sized investors.

We are in this mess because of the fragmentation of the markets. If there was a central market where all quotes and orders were published there would be total transparancy and best execution would be seen to be provided. The current set up does not provide
investors with what they need and no ammount of rules can put in place what has been lost

I cant see a solution through rule change but can if it is bt market structure change

Props for a well-balanced article. As for "Do we want a Stock Market that attracts investors and companies to list and find capital to build new factories or develop new products?", didn't Futures, Options, CDO, CDO2 and other structured financial products
undermine that notion well before HFT entered the scene and drove stock markets even further away from their original purpose?

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CEO of B.I.S.S. Research, founder of the BISS Independent Accreditation for all systems and services provided to financial services companies internationally. Guest Lecturer at Reading University and...